WALL STREET, CALIFORNIA | SECTOR SPOTLIGHT / JAMES F. PELTZ

Losing Streak May Be Over for Some Gaming Stocks

Here's an investment gamble: Bet that the nation's gaming stocks will soon rebound from their slump.

After surging in the first half of 1996, stocks of the nation's casino operators have turned and skidded the last five months, largely on fears that the industry's rapid expansion--mainly in the wagering capitals of Las Vegas and Atlantic City--is creating a casino glut.

Ironically, the stocks also have been hurt by a voter backlash against the expansion of gambling in other locales. On Election Day this month, voters in six states roundly rejected ballot initiatives to widen gambling in their regions.

The Chicago Board Options Exchange's index of 15 gaming issues has plunged 30% from its 1996 peak reached in mid-June, a loss all the more stinging in view of the broader bull market.

Among the industry's leaders, Circus Circus Enterprises Inc. has tumbled 12% in the last five months, MGM Grand Inc. is down 4% and Mirage Resorts Inc. has lost 7%.

In recent weeks the companies themselves validated investors' fears by reporting subpar financial results for the third quarter. The seven big operators that make up Dow Jones' casino group showed an average 10% drop in quarterly earnings versus a year ago.

But before investors place their chips elsewhere on Wall Street, they should note that gaming analysts are making this forecast: Many casino stocks are poised to turn back up, because the industry still has strong growth prospects and because there's likely to be more gaming mergers that could enrich stockholders.

Not all casino stocks may rise, of course. The best prospects are those with operations in Las Vegas and Atlantic City, where customer demand remains strong, according to Montgomery Securities analyst David McDonald.

Smaller operators focused on the burgeoning riverboat-casino business in Southern and Midwestern states, such as Players International and Lady Luck Gaming Corp., will have a tougher time because that business is ferociously competitive, the markets are new and untested and heavy promotions by the operators are eroding profit margins, analysts said.

"We expected riverboat results to be weak" in the third quarter because of the "increase in capacity in several emerging markets such as Tunica, Miss.," Prudential Securities analyst Joseph Coccimiglio said in a recent report.

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Overall, though, "the casino gaming market in the U.S. is both large and growing," McDonald said in a recent report. He expects total casino revenues--which hit $20 billion last year--to more than double by 2000, "implying an annual compound growth rate of 16% over the next five years.

That argument has critics. Dennis Forst of Sutro & Co. said Atlantic City "already has too much capacity, and it will have far too much in the year 2000" when expansions by Circus Circus, Harrah's and Mirage are completed.

Still, the prospect of more gaming mergers will help support the stocks, although takeover fervor has diminished sharply since the June announcement by Hilton Hotels Corp. that it was buying Bally Entertainment Corp. for $3 billion.

Analyst Scott Renner of Salomon Bros. said the industry is ripe for consolidation, although he knows of no current deals. Potential takeover candidates include Harveys Casino Resorts--currently trading around $16.00 a share--because it has a solid operation in Lake Tahoe, Nev., "that a lot of people would be interested in." There's also Station Casinos Inc., at $11.00 a share, "which has a tight grip on the local [gambling] market in Las Vegas," he said.

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A Losing Bet

After a strong start in 1996, gaming stocks have dropped sharply in recent months amid fears the industry is expanding too fast. Here's a graph of the Chicago Board Options Exchange index of 15 major gaming stocks.